Political road for markets has bumps ahead

HowardGold

Columnist

NEW YORK (MarketWatch) — As the first quarter ends, investors will turn their eyes to earnings reports, starting with Alcoa on April 10. How companies perform this time around will tell us a lot about the recovery’s strength.

But though earnings drive stock prices, actions by governments and central banks are driving the markets to a degree I’ve never seen before.

The Federal Reserve’s second round of quantitative easing (QE2) in August 2010 and the European Central Bank’s similar move to flood European banks with liquidity through long-term refinancing operations (LTRO) last December both helped spark big stock market rallies.

So, if you’re an active investor, you’ll need to watch the political calendar as well as quarterly earnings and seasonal market cycles for hints of what’s ahead. Later in this column, I’ll lay out my own scenario of how the markets could do for the rest of 2012. Read about Gold’s six big themes for 2012 on MoneyShow.com.

Like everything else, the political calendar is global, with important elections in Europe and the Middle East, as well as here.

The festivities begin in France, where the first round of presidential voting begins April 22. The top two candidates then move on to a second round on May 6th and the winner is elected president.

The incumbent, Nikolas Sarkozy, was popular early on for his efforts to shake up the country and move it in a more free market direction, but he accomplished only some of his agenda before the financial crisis hit.

In the crisis’s wake, Sarkozy and German Chancellor Angela Merkel (who is campaigning for him) have spearheaded efforts to save the euro and bring greater centralization to the European Union. But France lost its AAA credit rating under his watch, and the French people seem sick of him.

His likely opponent, Socialist François Hollande, doesn’t rouse much enthusiasm, but his populist policies may carry the day. For those of you who think President Obama is a socialist, Hollande is the genuine article. He wants to roll back the retirement age to 60 from the current 62, boost top marginal tax rates on the wealthy to 75%, and in a more extreme version of the Volcker rule, ban important national banks from engaging in speculative trading. He also wants to renegotiate the current EU treaty, but hasn’t spelled out how.

Sarkozy trailed Hollande in the polls by 24 points last October, but he’s narrowed the gap to only eight points now. France’s official presidential campaign lasts about six weeks (what’s wrong with them?), so he has time to make it even closer. No Socialist has occupied the Élysée Palace since François Mitterand left office in 1995.

A Socialist victory would likely spur a sell-off in Europe, particularly among French and other banks, as investors worry that Hollande’s policies would put France among Europe’s walking wounded. A Sarkozy upset could prompt a market rally, however.

Germany won’t hold elections until 2013, but Chancellor Merkel‘s fragile coalition is fraying as her party’s partner, the Free Democratic Party, implodes. Her Christian Democratic Union (CDU) may turn to the opposition Social Democratic Party (SPD) next year to form a government.

The German electorate is adamantly opposed to bailing out profligate southern European countries, and Merkel has followed a delicate balancing act which appeared to succeed with the recent bailout package for Greece.

She’ll have much less maneuvering room to deal with flare-ups in, say, Portugal or Spain over the next few months. So, if another debt crisis occurs, we could face a deep correction of the kind we suffered last year and in 2010.

In Israel, the coalition government led by Prime Minister Benjamin Netanyahu’s Likud Party looks strong a year before it must face voters. The opposition Kadima Party, founded by former Prime Minister Ariel Sharon, has just changed leaders as former defense minister Shaul Mofaz replaced Tzipi Livni.

With the Iranian-born hardliner Mofaz leading Kadima, Netanyahu would face no serious opposition if he decides to attack Iran’s nuclear facilities. That, of course, would cause oil prices to soar and stock markets to plunge.

But I’m not expecting that soon. On a recent U.S. visit, Netanyahu appeared to have narrowed his differences with President Obama over Iran. And there are reports the two struck a deal that Israel would give sanctions and diplomatic pressure more time to work — and wait until at least late this year to attack Iran.

And speaking about the U.S., have you noticed we’re having an election, too? Right now the polls show the president ahead in some key swing states.

The interminable Republican primary season also has taken a toll on likely GOP nominee Mitt Romney. A recent ABC News/Washington Post poll showed the former Massachusetts governor with a 50% negative rating, and his perceived continual flip-flopping has become a big problem. Read Washington Post story on views of Romney.

In fact, markets tend to be stronger when the incumbent party wins the presidency. Since 1901, during the 15 times the party in the White House was re-elected, the Dow Jones Industrial Average was up 1.5% in the first five months of the year. When the party in power lost, the Dow was down 4.6% during that time.

So, if stocks are still up through May, the markets may be predicting an Obama victory in November. Hey, folks, I’m only the messenger.

But after election day, things get a lot dicier. All the Bush tax cuts — on income, capital gains, and dividends — the payroll tax cut, and other tax breaks expire. And it will take an affirmative act of Congress to restart them. Can you just feel the love on Capitol Hill already?

Also, $1 trillion in spending cuts over the next 10 years kick in. And because Congress’s super committee couldn’t agree how to do it, the automatic cuts will take a meat ax to both domestic and defense programs.

And guess what we also may have to deal with again around then? The debt limit. I can’t wait to relive those glory days. How about you?

It all could add up to massive tax increases and spending cuts or ugly deals in the lame-duck Congress, or both. Or maybe even a government shutdown and another credit downgrade. Oh, and perhaps an Israeli attack against Iran. That would mean much slower growth, even recession in 2013.

So, enjoy the rally while it lasts, take some profits while you can, and set those acorns aside. Spring is here, but a long, cold winter may be looming.

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